01 December 2011 11:30 AM

There is a terrible air of desperation about the unlimited, co-ordinated central bank intervention for the eurozone. The real truth is that the decision of the European Central bank to pass around the collecting plate, in a move which dragged in the Federal Reserve, the Bank of England, Bank of Japan, the Swiss National Bank and the Bank of Canada is a mark of the disastrous lack of decision making capacity in the eurozone.

The failure of German Chancellor Angela Merkel and her cohorts to understand the miserable results of almost two years of inactivity in solving euroland’s catastrophe is to bring the whole world banking system back to the precipice of the Autumn of 2008.

Even Beijing, never before part of such an operation felt the need to do its bit, with the Bank of China easing the reserve requirements imposed on the commercial banks. In effect these eased credit conditions in the Middle Kingdom, the world’s biggest hold of foreign currency reserves.

The biggest threat to output in the major Western nations is a second credit crunch as banks refuse to lend to each other because no one can be sure who is holding rotten sovereign debt.

In the current turmoil the toxic debt takes the form of sovereign bonds issued by euroland’s periphery. Last time out in 2007-09 it was America’s sliced, diced and repackaged trailer park mortgages. The central bank action is intended to ease the tension in the inter-Bank markets ahead of the next ‘do nothing’ euroland summit on December 9 and over the Christmas holiday period when financial groups traditionally tidy up their books.

The need for urgent action was underlined by a couple of events. Overnight on Wednesday credit markets in the euro area came close to freezing over and at least one major bank, possibly French, came close to ruin.

Adding to the disruption was the unhelpful intervention of the credit rating agencies who still seem to be fighting the last crisis. Having been caught flat-footed over sub-prime in 2007-08 they have tended to take the lead in the sovereign debt crisis downgrading economies, including that of the United States, and putting the red pencil through bank ratings.

Each lowering of ratings makes it more expensive and in some cases harder to raise cash on the money markets where banks lend to each other. The latest assault on 37 global banks, including Britain’s Barclays and HSBC, added to the tensions in financial markets. In the US the shares of Bank of America temporarily dropped through the psychologically important $5.00 level, territory not seen in living memory.

The cut in the cost of borrowing dollar reserves and the unlimited amounts of dollars made available are intended to prevent the second credit crunch from tipping the advanced nations back into crisis. Almost certainly this is a false dawn.

The Financial Services Authority, picking up on warnings from the Bank of England a week earlier, is telling British banks to prepare for a disorderly breakup of the eurozone. Clearly, there is a belief on Threadneedle Street (never enthusiastic) that the game is up for the euro.

The reverberations in London – which handles most of Europe’s foreign exchange activity – could be enormous. Word has gone out from investment banks like UBS that the fix is in for December 9 and Chancellor Merkel will finally receive the robust assurances on fiscal co-ordination she has been looking for and will relent on using the European Central Bank more flexibly. The evidence for this is flimsy other than then fact that Berlin recently has gone quiet on the next steps for the single currency. But the message has been the same for the last two years and after almost a score of high level meetings, each promising progress, the disappointment is entirely predictable.

The George Osborne cry of ‘six weeks to save the euro’ and David Cameron’s ‘big bazooka’ turned out to be no more than empty rhetoric. The ability of central banks to make a short-term difference was demonstrated by the joint central bank action in the dollar markets. But this is like applying an Elastoplast to a wound pouring with blood.

The idea that Merkel is going to give into pressure and let the Frankfurt based European Central Bank send up the helicopter and drop euros all over the ClubMed looks as unlikely as ever. But unless the ECB is unshackled, so that it can act like any other central bank by printing money, buying bond and taking on lender of the last resort powers the game is up.

The markets are too impatient to wait for the broader political and fiscal reforms necessary for Chancellor Merkel and Berlin to relent. Be prepared for meltdown.

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17 November 2011 10:38 AM

The sudden departure of the International Monetary Fund’s Europe director Antonio Borges, in the middle of the greatest economic crisis in Europe since the end of the second world war, does not come as a huge surprise.

Borges has a habit of speaking his mind, which in the rarefied world of the IMF is not regarded as an endearing habit.

As lender of the last resort to most of the world the IMF hasn’t done openness very well in the past. Its officials were encouraged to keep a low profile and has been known to arrive on rescue missions in deep disguise.

But this changed in the Dominque Strauss-Kahn period when a new, user-friendly IMF willing to share its secrets was born. The result has been somewhat chaotic and hasn’t necessarily gone down well in the more conservative reaches of the Fund.

I was present at a Borges briefing in Washington in late-September when he portrayed the euro area crisis in much more graphic terms than his new boss Christine Lagarde would have regarded as helpful. Borges went on to suggest that Britain’s austerity programme wasn’t working in terms of growth and we should be putting together a ‘Plan B’ to avoid a deep recession.

It was not a comment which pleased the Chancellor George Osborne.

The immediate reason given in the corridors of Washington for the European chief’s resignation was that Borges misspoke when he suggested that the IMF could directly buy Spanish and Italian bonds to alleviate the crisis. The Fund has never indulged in direct bond buying and has been at pains to be junior partner in the European rescues.

Borges' comments may have been particularly embarrassing for Madame Lagarde who is regarded as far too close to the Europeans for comfort and is sensitive to the thought that the Washington-based institution does not want to be seen as a branch of the EU based in London.

The successor to Borges, Reza Moghhadam, is experienced at dealing with crisis and moved with speed during the 2008-09 to develop new facilities to help countries seeking to combat its aftermath. He is much more likely to talk in traditional technical IMF terms – with a love of jargon – that in the more outspoken words of Borges.

The mystery about Borges departure is that is for ‘personal reasons.’ That could certainly be said was the reason for the departure of DSK, after his problems in a New York hotel, but is a clumsy way of announcing that someone is leaving because of policy differences. This is especially so given the Fund’s recent difficulties in the ‘personal’ department.

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15 November 2011 6:16 PM

Consumer price inflation of 5pc, when the target set by the government is 2pc, cannot be regarded as a good outcome. In fact it has been positively cruel for savers, particularly the elderly, who on the broader retail prices measure have suffered a painful 20.1pc inflation hit since the start of the credit crunch in August 2007.

But at least there is some light starting to emerge. In his letter to the Chancellor the freshly knighted Sir Mervyn King makes it clear that he expects inflation to fall back sharply over the next six months as VAT falls out of the inflation measure and companies find it harder to raise prices because of the slowdown caused by the euro area crisis.

Indeed, there is a view, supported by King’s letter to the Chancellor, that inflation will fall to 2pc by the end of 2012 if not earlier. Indeed, it could even drop below.

The immediate cause of the drop in prices is the intense competition on the high street among the grocery chains desperate to hang onto business during tough times for households.

Several major clothing retailers including Marks & Spencer, in the middle market, and Primark at the value end of the chain have made it clear they would rather take the hit on profit margins – in other words they are absorbing cost increases such as the soaring price of cotton – rather than lose markets share.

It is not surprising in some ways that the UK has a higher inflation rate than many of our European competitors. There has been a sharp reduction in the value of the pound, which raised import prices, and we have a much more open economy.

Normally, a devaluation of the scale the UK experienced would lead to a degree of import substitution – domestic producers becoming more competitive than their overseas counterparts – but so far the response has been poor. However, as we report today there has been some repatriation of outsourced services.

If prices do start to drop rapidly, as King is indicating, that also creates an opportunity. It would give the Bank the headroom for a further round of quantitative easing beyond that which already has taken this. The Old Lady has been more aggressive in asset purchases, in terms of the size of our economy, than almost every other major central bank.

A further pointer that the market is not too worried about the inflation outlook is the interest rate on British government bonds – or gilts. The ten year bond yield at 2.13pc is at or close to its lowest level since 1898 and the gap with the German bund yield is narrowing daily.

This largely reflects the UK’s safe haven status at a time when eurozone instability is becoming worse. But it also suggests that investors are confident that the current inflation rate is a blip which will pass.

Investors should follow the Warren Buffett mantra and look for good branded corporations, with large cash reserves, global reach and decent payouts.

There are a surprisingly good number which may explain why equities are not suffering quite as much in the current euro/banking eruption as in 2008.

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10 November 2011 12:02 PM

President Sarkozy and France cannot look at Italy’s travails with any equanimity. The bond market’s loss of faith in Rome brings the eurozone crisis a step closer to France.

Throughout the Greek crisis and at the G20 summit France sought to adopt an aloof posture as if it stood there shoulder to shoulder with Germany as bulwark against the soft fiscal policies of the Club Med. But the reality is that with its large public sector France is struggling against many of the same forces as Italy. In addition its banks are hugely vulnerable to Italy with holdings of Euro 600 billion of Italian, Spanish and Greek debt according to data collected by the bank for International Settlements in Basle.

The concern now is that the contagion will now hit France with bond yields there rising as asset managers move out funds and concern grows about its ability to maintain a triple ‘A’ top grade credit rating. It is noted that the gap between German and French bond yields has drifted out since July reflecting the risk of a downgrade and the process speed up in latest trading.

Not that Britain can afford to be complacent about Italy’s problems. The county is out eighth biggest trading partner but more seriously the UK banks are among the biggest holders of Italian debt with Euro 49bn thought to be on their books. It Italy were allowed to default, a distinct possibility, the Cameron government might find itself having to take new stakes in the UK banks which would find it hard to raise capital from the private markets.

The ‘soft’ solution to the Italian crisis is to give the European Central Bank more power to buy Italian and other bonds from the banks providing liquidity to the banking system – a form of quantitative easing. This stretches the ECB’s mandate but if Germany is serious about wanting to hold back the tide of default it may be the only short term solution. It is unlikely, however, that new ECB president Mario Draghi would press ahead unless he felt he had hardliners in Berlin and at the Bundesbank on side. What is clear, however, is that a prolonged period of uncertainty – of the kind which was allowed to build up around Greece – is not possible if a whole is not to be blown in euroland’s firmer Northern tier which includes France.

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08 November 2011 12:13 PM

Italy rapidly is becoming the new Greece. With a Parliamentary vote looming on the budget bond yields are perilously moving close to the tipping point of 7pc which is considered unsustainable and tipped Greece, Ireland and Portugal into the hands of the European Commission and International Monetary Fund.

With bond rates hitting a new post-1999 high of 6.74 per cent there will be very nervous people in Brussels, Berlin, Paris and Rome.

France has sought to erect is own Maginot line by a new painful dose of budgetary austerity including a 5 per cent super-tax on big corporations which will make it less competitive.

But the last thing President Sarkozy needs is the crisis lapping at his door ahead of the presidential election.

The Italian debt numbers are mind boggling. The country has Euro 1,900 millions of debts a figure far beyond the capability of the European Central Bank or the bail-out fund the European Financial Stability Facility.

It faces an interest rate bill of Euro 85bn alone next year to service its debt but on top of that has Euro 300 billion of debt to roll over, before it even starts to finance the new deficit.

There are truly terrifying numbers. What is absolutely clear is that Europe’s banking system has absolutely no chance of handing a default of the scale of that of Italy. It would bring almost every sizeable bank in Continental Europe tumbling down with the French and Italian banks the most vulnerable.

It makes an absolute nonsense of the modest Euro 106 billion recapitalisation already proposed by the European Banking Authority.A figure triple or quadruple this would be necessary to secure the safety of the banks and that would almost certainly a widespread programme of capital injection buy governments or public ownership.

The only way of handling an Italian bail-out is through the ‘Big Bazooka’ of the International Monetary Fund. The difficulty is that last week’s G20 in Cannes failed to agree on the size of the new resources needed and an Italian rescue would drain the Fund dry, leaving nothing left for the rest of the world. This would be deeply destabilising situation.

The worst of all this is that it could have been avoided. If eurozone leaders had shaken off their denial 19 months ago, when Greece’s problems first loomed, and moved systematically to build barriers against default and bankruptcy they might have weathered the storm. But they haven’t and in the process have placed not just their own prosperity but that of the whole world in jeopardy.

People may not be in soup lines yet in Paris or Berlin just yet but the impact of flawed decision making will be horrendous for the poorer and needier countries of Eastern Europe and North Africa.

As for Britain, our fiscal problems may be under control, but the double dip, the banking meltdown and surging youth unemployment all pose daunting problems for the Coalition which will make the row over immigration look minor league.

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07 November 2011 11:30 AM

No sooner had the political logjam in Greece been eased, with the emergence of a unity government, that market attention has switched to Italy. While the world has been focusing on the euro periphery it is Italy which has always been the elephant in the room. As the third largest economy in the eurozone neither the European bail-out fund or the recapitalisation plans for the region’s banks are adequate if Italian default became necessary.

Hence the hurried efforts at last week’s G20 to put in place an International Monetary Fund safety net.

Just how critical the situation in Italy has become was evident at the opening of Europe’s financial markets. The yield on benchmark Italian 10 year bonds jumped a 0.33 percentage point to 6.58 per cent, the highest level since the euro was established in 1999.

More serious than that with borrowing costs at this level Italy will find it all but impossible to cover the interest payments on its gross debt which stands at 121 per cent of gross domestic product. In the past Italy has been able to weather the storm because of the willingness of Italian banks and the broader population to hold Italian bonds. But although the current yields may look superficially attractive they represent a signal that the country potentially could default on its debt.

These fears affected equity markets across Europe with the FTSE100 sharply down in volatile trading.

The pressure will not be on in Italy for Greek style political solution, some kind of government of national unity, which can deliver the economic reforms. No one believes that Italy’s clown-in-chief Silvio Berlusconi is capable of implementing the reforms discussed at the G20. He seems to think that he can bluff his way through quarterly IMF inspections.

But with the eurozone apparently powerless to impose conditions on Greece it is going to be the IMF which will have to show the steel. Indications are that the new deputy managing director the American David Lipton, is the best person to wield the knife. For all her charm Madame Lagarde, the managing director, is too close to her European colleagues and too political to be taken very seriously by Angela Merkel or President Sarkozy. And as the Americans are by far the biggest shareholders in the IMF and can probably carry the Japanese and other big shareholders with them it is they who will dictate the terms as they did in 1976 when Britain borrowed from the IMF.

Once again the G20 and Europe have failed to deliver and the market uncertainty moves the whole world back to the brink of recession even of the Asian economies seek to pick up some of the slack.

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02 November 2011 12:05 PM

The Archbishop of Canterbury’s embrace of a Tobin Tax on financial transactions may win him new friends at the ‘Occupy London’ anti-capitalist protests outside St Paul’s but will cause horror at the Treasury.

Such a tax will only work if it is accepted globally. But the emerging market countries of Asia are refusing to have anything to do with it. Indeed, Singapore – which has some of the lowest tax rates in the world – already has attracted the trading arms of some banks seeking to escaping the existing bonus tax and 50pc tax band in the City of London.

Rowan Williams call does, however, address a grievance among the ‘Occupy London’ protesters which I share. The bankers have taken Western consumers for a ride. In 2009, with the ink barely dry on the British and American banking bail-outs, they paid themselves the most obscene bonuses of all time with Goldman Sachs – a loss maker in the most recent quarter – the most greedy of all.

The original idea of a tax on all financial transactions was first proposed by the late Nobel-prize winning economists James Tobin in 1972. He argued that a micro-tax of less than 0.5pc on foreign exchange deals could yield billions of dollars which could be used to fund development in poor nations.

The concept was revived by Lord (Adair) Turner, chairman of Britain’s City regulator the Financial Services Authority, in the aftermath of the financial crisis of 2008. He suggested it as a way of punishing the banks for their greed and social neglect.

In 2009 the idea was explored at the G20 summit of the richest nations in Pittsburgh at which Britain insisted it could only support such a tax if it were adopted globally by every major trading nation. This has never happened although Britain has imposed its own tax on the worldwide balance sheets of UK banks which yields around £2.5bn a year which is as much as Alistair Darling collected from his one off bonus tax in 2009-10.

In July of this year the idea was taken up by President Sarkozy of France and Angela Merkel of Germany at their Paris summit where they proposed that such a tax should be levied across the European Union.

The proposal, which has become official policy of the countries within the euroland area, was widely interpreted as punishing Britain for playing host to financial speculation. Some 70 per cent of financial transactions in Europe are conducted through banks and exchanges based in the City of London.

The financial transactions tax (FTT) has been hotly opposed by Chancellor George Osborne and the UK Treasury which believes it would be harmful to London’s role as a business centre. The government has vowed to veto the proposal if it comes up before EU heads of government in Brussels.

Some reports have suggested that such a tax in Europe could raise up to £50 billion a year. Imposed world-wide the prospective take could one quarter of a trillion pounds. A good reason for having a transactions is that it might help to halt exotic dealings not essential for global commerce. This might slow the pace of speculation.

A more likely outcome is that we will see foreign exchange and derivatives dealings conducted through Panama or Pacific Island subsidiaries and exchanges out of sight of the G20 economies.

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01 November 2011 10:56 AM

After 18 months of rioting on the streets and growing internal dissension the Greek government of George Papandreou finally has decided its has to listen to its own people and called a referendum. Who can blame him.

The high handed way in which Brussels has treated Papandreou, like an errant schoolboy, has not been edifying. Moreover, the German disdain – for a country it once brutally conquered – has been hard to take.

No one doubts that under the protection of the eurozone Greece lived horribly beyond its means. It borrowed too much, allowed real wages to rise one by one-third more than justified and enjoyed an unsustainable boom.

But the richer eurozone countries, which were doing much the same, must take the blame for failing to use their own enforcement mechanisms.

By calling a referendum Greece is deciding that in the cradle of democracy it should be having its own say and not just on the streets. It is a chance for the silent majority to speak.

They clearly are being asked to take a real hit; cuts in living standards, poorer retirements and a change in the work life balance. The choice is breaking free from ordained cuts in living standards and austerity and Argentine style UDI.

But no one should underestimate the difficulty of secession from the euro. That too will have a dramatic impact on lives within Greece as the Drachma or its successor is introduced. Bank deposits by businesses and households will be decimated by devaluation and that could bankrupt many businesses. The real value of wages, profits and assets will be sharply cut immediately and the banking system will need to be rebuilt from the grassroots upwards.

But it would give Athens the chance not just to take a 50pc haircut on its international debt but to cancel it all together. It would also allow a dramatic devaluation of the currency which would make Greek tourism and exports highly competitive again.

The Argentine and Russian experiences tell us that such shocks can be reversed within a couple of years although relations with the global financial community make take longer to repair.

What the Greek decision does expose is the foolishness of euroland leaders and regulators not to confront the problem of the banks immediately and to put more money behind the counter.

The Euro 106bn bank bailout is hopelessly short and an least three times that amount of capital is needed. If it cannot be found in the private sector then governments must do it as in the UK and America in 2008-09.

Greece has thrown down the gauntlet to the euroland leadership. That ought to be enough to end the policy drift in Brussels and the focus on irrelevancies such as the Financial Transactions Tax. But it is doubtful.

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31 October 2011 11:51 AM

We should not be in the least bit surprised that the Bank of England has declined to provide the Treasury Select Committee of minutes of the Court – its governing council – in the run up and during the Northern Rock banking crisis of 2007.

This was not the Bank of England, its governor (Sir) Mervyn King or its then deputy-governor Sir John Gieve’s finest hour.

When I was writing my book on Northern Rock in 2007-08 ‘The Crunch’* I took the opportunity to interview several members of the Bank of England’s Court. Those I talked to spoke of their frustration about being kept out of the decision making loop. The Court was not summoned to the BoE to be told of the ‘lender of the last resort’ loans made to Northern Rock, at the then request of its chairman – the science writer Matt Ridley – and its chief executive Adam Applegarth until it had already been revealed on national television by Robert Peston in his famous scoop.

The late acknowledgement of the problem by Bank officials was in keeping with the lack of information provided to the Court on financial stability matters. The Court was kept well informed on monetary developments following an earlier row between the bank and external Monetary Policy Committee members over the lack of research facilities provided by the Bank.

It is my understanding that some months before Northern Rock ran into difficult, in August of 2007, the Court had requested that Gieve – who ran the stability wing of the Bank – draw up a policy document giving a clearer definition to the Bank’s role and scope in financial policing.

The Bank’s role, at the time, was blurred because responsibility for banking regulation had been switched by New Labour to the newly created super-regulator the Financial Services Authority a decade earlier. The bank’s focus on monetary policy made financial stability the poor relation.

Nevertheless, the Bank produce a financial stability report, on a regular basis, and it was a previous deputy governor Sir Andrew Large who in that report had raised concerns about the levels of liquidity, ready cash, held by the commercial banks and other City organisations.

Large feared that in the case of an unexpected event, such as the credit crunch, they would not have the cash reserves to deal with it. And he proved right.The Court which was peopled with a number of senior bankers and industrialists could well have provided the firepower needed to beef up the bank’s financial stability role had it been requested. But this was not a priority among senior Bank officials who steered away from the whole vexed question of potential stability problems to the banking system.What Gordon Brown and Ed Balls did not realise when they created the FSA, or chose to ignore, is that the Bank of England can never be divorced from financial regulation. In the case of crisis central banks are the first port of call because they have the balance sheet to support emergency help to the banking system.

This disconnect was at the root of the poor early handling of the 2007-08 financial crisis.

The Court should co-operate with the Treasury Select Committee in releasing the relevant papers and not engage in pointless obstructionism. The present tangle makes it all the more important that we have a judicial or Royal Commission – with the power to subpoena documents – to look into the events and regulatory failures which led to Britain’s humiliation starting with the run on the Rock.

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26 October 2011 10:27 AM

It was the late Israeli foreign minister Abba Eban who once said of his Arab opposite numbers they ‘never miss an opportunity to miss an opportunity.’

I feel much the same about ministers from the 17 euroland countries or (to quote the inaccurate BBC version) the countries which use the euro. For 18 months now they have held summits, caucused, met and held countless Councils of Ministers and not once has what has been announced ever been good enough to fulfil market expectations.

There is a view that because equity markets have bounced 10 per cent in the last few weeks the end game must be in sight. Don’t bet on it. Share markets have never been good forecasters as the Nobel prize winning economist Paul Samuelson famously noted with his jibe about predicting nine out of the last five recessions.

Take the banking bail-out. There appears to be a consensus that the Euro 100bn or so of recapitalisations recommended by the European Banking Authority will be enough to stem the rot.

Of course it won’t. This is the third attempt of the EBA to stress test the state of the European banking system and each time they have failed to convince.

After all it was only a month ago that the far more convincing International Monetary Fund suggested that the capital shortfall for the Euroland banks was closer to Euro 200 billion and if market connections – the so called shadow banking system – were taking into account the shortfall would be Euro 300 billion.

Even this would be a gross underestimate given the unquantified and unknown scale of the shadow banking system.

The idea that scaling up the current Euro bailout fund, the European Financial Stability Facility from Euro 440bn to say Euro One Trillion would somehow deal with the problem is farcical. At least Euro 2-3 trillion would be necessary if the big bazooka – enough cash to deal with not just the euro periphery but Spain and Italy too – is necessary. Anything short of that will be seen as feeble but the Europeans have had a long habit in this crisis of announcing very feeble steps – as at the July 21 summit – and seeking to pretend that something profound has been achieved.

Even if long-term commitments to more fiscal union are made, in an attempt to clothe the rescue in economic respectability, the implementation ability will be virtually nil. There is no way for instance that he low-flat tax nations of the East and the Baltics – which have prospered on the back of a raw form of Anglo-Saxon capitalism – are going to abandon that model for the very expensive German social market with its high taxation levels.

Similarly, as we have seen in Greece (and this also applies to Italy) the implementation skills of the tax and fiscal administration in much of the ClubMed is zero.

Even if the big bazooka were to be produced the vexed issue of how much Greek default will be acceptable to the private banking sector has to be dealt with. The proposed figure of a 60 per cent reduction in the face value of debt would require far bigger writer offs from balance sheets under mark-to-market accounting rules.

But it would also trigger concerns of a 1980s Latin American style domino effect with other countries seeing default as the soft option. The impact on the banks in such a case would be catastrophic and could make the post-Lehman panic look like a tea party.

Given all of these imponderables the latest series of summits should not be looked on as providing the answers. Indeed, on reflection they could be a signal for more market disruption.